DeFi 2.0: Assets Catching up To Primitives

Transcript

My name is Spencer Applebomb and I'm a general partner and the co-head of venture at Multicoin Capital. Uh, a few weeks ago, my colleague Cheyion and I published an essay that we call DeFi 2.0 and that's what I'm going to walk through today. Uh, the basic thesis is actually pretty simple. Um, all of the infrastructure that we built in the first generation of DeFi was built around crypto assets. So things like Bitcoin, ETH, Soul, uh Hype, etc. But now we have treasuries, equities, uh credit markets, FX, uh all of these things are starting to move on chain.

And so as the assets themselves change, the financial infrastructure on underneath them needs to change as well. So this talk's going to be in three parts today. Uh first, why Defi 1.0 looks the way that it does. Uh second, what will change as real world assets come on chain. And then third, where we think that creates investment opportunities for us and others. [snorts] Uh so before we dive in, my legal team asked me to tell you that nothing you'll hear or see today is financial advice or an offer or solicitation for multicoins advisory services. Uh all right, let's jump in.

[snorts] So if you come from Tradfi and look at the core products that emerged in DeFi pretty early on, uh a lot of them look pretty strange and candidly pretty inefficient. Um, AMMs, for example, leave passive liquidity that sits on a curve and in a lot of cases, they don't really offer great execution. Uh, over collateralized lending asks you to put up $150 to borrow a h 100red. Um, on borrow lend protocols, rates can swing from, you know, 5 to 20% in just a matter of days. And then lastly, instead of dated futures, the crypto industry converged around this per product that never expires. Um, from the outside that conclusion might be that DeFi just rebuilt finance, but in a worse way. But

I actually think that's the wrong takeaway. [snorts] Um, these products look strange because they weren't actually built for traditional assets like a treasury or an equity or, you know, even traditional market participants like asset managers. They were built again for crypto assets, Bitcoin, ETH, Soul, and even more so thousands of longtail tokens. And and those are just fundamentally different assets. Um, for example, these assets that we know as tokens have 50 to 100% annualized volatility instead of the call it 5 to 15% on the traditional side. Um, crypto assets generally don't have cash flows and they don't mature.

Um, it's often wallets that are pseudonmous that are borrowing instead of having known counterparties where you can actually call margin after the fact. And then on the execution side, a lot of it is, you know, generally retail trading small lots rather than institutions chain uh trading institutionalized blocks. So once you start from that premise, almost everything about DeFi 1.0 actually does start to make sense. And we're going to talk about a couple of examples. Uh let's start with AMMs. Um if I'm trading Apple stock or, you know, uh Euro USD, the market for that stuff already exists, right? There's dozens of market makers out there competing over what is effectively basis points. Um, but if I launch a token on pump fund this

afternoon or I raise a small round on metad for example, my problem isn't really getting the spread down from 20 to basis point 20 basis points to 10. The problem is getting a market to exist at all. Uh, and AMMs have solved that for this industry pretty well. You have two assets in a pool, you immediately have price discovery and you can start acrewing some liquidity. So yes, obviously AMMs are capital inefficient, but capital efficiency was never really the problem that these things needed to solve. Lending's also the same story, right? An anonymous wallet has no income statement. It has no credit history. You can't underwrite the borrower and so you have to underwrite the collateral. If you look at this chart from Galaxy onchain USDC borrow rates have gone from, you know, two to over 15% and back

several times throughout history. in Tradfi, we think that's probably unacceptable. But again, if you're borrowing, let's say, $10 million of USDC against $20 million of soul, you probably don't care because the soul might move 10% tomorrow. So, who cares about the annual interest rate changing a couple percent. Um, per actually follow the same logic. So, crypto assets don't mature and traders generally just want continuous leverage exposure to whatever the underlying is and and that's why PERS have become so popular. Um, I think the the important TLDDR from the last two slides is DeFi 1.0. It wasn't really an immature version of Tradfi. It was actually pretty well optimized for the crypto assets that people were trading and lending and

borrowing. [snorts] Um, so this slide is the one where I think things actually get interesting. So I think we can all agree, that's probably why we're here, that the asset base underneath DeFi is changing. Um, treasuries and equities are already moving onchain and credit, commodities, FX, etc. those are probably next. And the scale of the opportunity importantly is here is really enormous. Um, Tradfi markets trade roughly $20 trillion a day whereas crypto trades about a third of a trillion. [snorts] Um, in our view, uh, thus far most of the RWA conversation has been about tokenization itself, right? Meaning, how do we actually get these assets onto a blockchain? But we think the more interesting question is what happens once those assets actually

do get there. Because these assets behave so differently from what we've known as traditional crypto assets, we expect a whole new set of primitives to emerge. So we think that RWAs differ from tra uh from crypto assets um in five broad categories. So first RWAs generally have lower volatility and they have tighter spreads because they're more liquid. Um second a lot of them have duration and cash flows. Uh third they usually generally speaking make for better collateral um and the market participants i.e. the borrowers you can actually identify. Um fourth much larger institutional participants are already trading these assets. And then fifth

we're going to have portfolios on chain that span lots of different asset classes. So in the next few slides I'm going to take these one at a time. And I think the pattern to watch for is every time you have a new asset, a primitive that previously looked unnecessary in DeFi 1.0 suddenly starts to make a lot of sense. Uh so the first difference is volatility and and with it how tight spreads are. [snorts] Uh if you buy a meme coin and you eat 2% slippage, you probably don't really care, right? The token might be up or down 30% an hour later. Uh but if you're trading treasuries or FX for example, 10 BIPS can literally be the economics of the entire trade. And so market micro structure starts to meaningfully matter.

And so that changes the type of liquidity provisioning you actually want, right? You don't want passive liquidity sitting on an AMM curve. You want professional market makers constantly repricing off of where the asset is trading on other venues. And so that's why we think order books, RFQ systems, and prop AMMs that you that we're starting to see on Salana are becoming so much more important. And these markets, importantly, are actually a lot easier to bootstrap from a market maker perspective because they're already trading these assets in Tradfi. And there's plenty of traditional venues that they can hedge on. I know that there's a lot of commentary out there that DeFi is not ready for these primitives, but if you just look at this data on the slide, right on a million-doll order, Hyperlid and Lighter

are within a few basis points of Binance. And actually, Hyperlid is quite competitive. [snorts] Um, in in some cases, they actually do offer better execution. And then on Salana, prop AMMs now offer tighter soul USDC liquidity than Binance, which is the most liquid market on Salana. So set another way, DeFi is actually ready for prime time in these more advanced market micro structure primitives. Lower volatility also changes options, right? Several years ago, there were many different companies uh think Ribbon, Katana, Friction and a few others who built covered call vaults on uh blockchains like Ethereum, Salana and others. The idea there was you could deposit soul, ETH or Bitcoin. you could

sell calls against it and collect the premium. And actually that product's worked in Trady forever. The problem uh fundamentally is that soul or ETH or you know any of these crypto assets, they can go up or down 50% in a month. And so if you're giving all all of that upside away for a few points of premium, the product just is not that compelling. But if you point that same exact product at an equity that you know, say might appreciate 10% in a year, a covered call actually starts to make a lot of sense. and so do other interesting structured products, things like collars and downside protection products. So, we think that option vaults weren't necessarily wrong. Again, they were just built for the wrong assets at the right time. And honestly, I think that's true of the entire options market and crypto

more broadly. You know, pers have won in crypto because a lot of the underlyings have 100% volatility. So if you're 3x long, I don't know, a height per, even though it's a delta 1 derivative, you can still get a lot of skew and you know, maybe some dopamine from that. [snorts] But once the underlyings are equities, I expect options onchain to matter just as much as they do in traditional finance. The second difference between traditional assets, i.e. RWAS and crypto assets is duration. Bitcoin, ETH, soul, etc., uh they obviously don't have a maturity date, but most real world financial obligations do, right? They have dates attached to them. So, if a company's borrowing $100 million for 3

years to, I don't know, fund some capex project, it probably needs to know whether its borrowing cost is going to be $5 million a year or 10 million. Or if an asset manager buys a bond that's yielding 6% and they're borrowing at 4%, the 2% spread is the trade. if funding moves on them to 6% tomorrow, the trade's obviously gone. Um, in these cases, in the real world, rate certainty goes from, you know, a a nice to have to basically essential. So that's why fixed rate, fixedterm credit becomes so much more useful. Uh, Morpho with their new midnight product, for example, is doing this today with rates that are set by bids and offers at specific maturity dates. And then once

you have those markets, you can actually start to get a real uh yield curve like you see on the slide. So things like three-month yield, 6 months, one year, eventually even multi-year. Um we think that this is generally pretty important for the industry because it's a benchmark that everything else can get priced off of. Uh a borrower with a three-year obligation can actually get funded for 3 years and also the curve itself can tell you what the market expects for rates and risk over time. Uh DeFi today essentially does not have that signal. [snorts] Um and then another interesting thing is once you actually have a a curve rates themselves become tradable.

So Pendle and our portfolio company Exponent for example they separate out principle from yield. Uh historically the yields that people were trading in DeFi were things like the staking yield or the borrow rate on a funding rates on Binance or eventually actually points on DeFi protocols. With RWAS though it becomes things like treasury rates, credit spreads, dividends and really any sort of contractual cash flow that you can imagine. Uh Boros, which is a different Pendle product, actually does the same for fixed versus floating swaps. Uh today it's just on per funding on the major centralized exchanges, but in the future that structure could actually help you out hedge actually help you hedge out some of these real

interest rate risks. And then [snorts] lastly, dated futures will actually start to matter in crypto. I know that's kind of a taboo thing to say. Um, historically, nobody's really used them, and that's because the assets that you're trading don't have duration. But if I owe someone euros in 6 months, my exposure has a date, and my hedge probably should as well. [snorts] Um, the third difference between RWA and traditional crypto assets is just the value of their collateral, right? RWAS, Visav are just much better collateral than traditional volatile crypto assets. um in early crypto lending protocols or or even stable coin protocols, you kind of had to assume that the collateral could drop a third 50% overnight. And that's why Maker Dow in the early days

had you put up $150 of ETH to to borrow out $100 of Dye. [snorts] But if you swap out ETH for treasuries and you keep the borrower anonymous, maybe that haircut falls to $10, right? So now you're looking at a 91% LTV instead of 66. And then if you look at the third row on the chart here on the left, if [snorts] it's a known [clears throat] institution who's KYCed on chain that's posting treasuries in the repo market, maybe they can borrow at 98%. So better collateral will get you a lot of the way there. And then the the last step, which I'll talk about a little bit on the next slide, is actually knowing who's on the other side of the loan.

So like I just mentioned, RWA can change the borrower profile, too, because now you can actually underwrite them, right? an Ethereum wallet, it doesn't have uh financial statements, but a company obviously does. So, you can [snorts] look at things like cash flow and liabilities, the the management team, their repayment history, uh and most importantly, what legal claims you actually have if there's a default, right? If I go bust on a decentralized derivatives exchange, no one can can do anything about it. Um, [snorts] Maple's already doing a version of this onchain with institutional borrowers and and candidly, a lot of the early undercolateralized lending networks in DeFi struggled because there was just a ton of adverse selection, right? The the borrowers who showed up to these things like a goldfinch were in a lot of cases

the ones who couldn't really get credit anywhere else either because of just their creditworthiness or maybe the jurisdiction they were operating in. >> [snorts] >> Um I think though you know as the regulatory clarity improves in the US legitimate businesses can actually start to borrow on chain and that will create a lot of interesting riskadjusted opportunities for lenders globally. The fourth difference here between RWAS and crypto assets is who's actually trading them in a lot of cases and then like how big those orders are. So if I buy you know $10,000 worth of Ethon chain, nobody really cares that it's that it's transparent and visible. But if I'm an asset manager that's doing a T-W for $100 million of some midcap equity, showing that order to the market

can be extremely expensive. Uh, and we at Multicoin actually learned this one firsthand. So when we were building a position in hype in our hedge fund, anyone with a wallet tracker could see our position in real time. So we then tried to go and undoc tokens to new wallets. Um, and when we did so, the market absolutely freaked out because people thought we were selling and we had to tell everyone that we weren't. So, Tradfi solved this a long time ago with primitives like block trades, uh, RFQ systems, and dark pools. And those structures are now starting to come on chain by some of the companies that you see in the bottom left here. I expect a lot of these protocols to be a meaningful share of onchain trading volumes within just a few years.

So the last difference I'll highlight which I think is actually one of the most underappreciated is what the portfolio itself looks like. If you think about how you know I live in the US, someone like me would hold assets today. I might hold Bitcoin on Coinbase, uh equities on Erade, options on Robin Hood, uh prediction markets on Kelchi, FX on some sketchy CFD broker, and then maybe uh private equity shares on a platform like Clarity. So I would have six different accounts with six six different margin systems and six pools of collateral and none of them would actually talk to each other. So as an example, if I was long an equity in one account, but I owned a put option in a different one, nobody would see the

hedge and I wouldn't get credit for it. So I'd have to post collateral twice. Um, honestly, the way DeFi works today isn't much better. Um, in crypto though, that hasn't really mattered because most of the assets that people own are just the same beta anyways. But once you have rates and credit and equities and FX and and all these other assets we're talking about coming on chain, there's actually going to be real offsets everywhere that you can net against each other. And so we think that a DeFi native prime brokerage product is extremely interesting. And our portfolio company uh project zero is actually building this on Salana right now. The I the the grand vision here is you have one balance sheet across every asset class that is entirely portfolio margined and

allows you to get maximum capital efficiency. So the natural question is why do we at Multicoin actually care about any of this from an investment perspective. Um I think there's really two different TAM expansions that are happening at the same time. The first one is obvious, but I think the second is actually pretty interesting. So the first obvious one is simply more assets, right? Global bonds are about 161 trillion. Uh equities are about 158 trillion and and all of crypto. I don't know what the I don't even looked at prices today, but call it under three trillion. [snorts] Uh tokenized RWAS are about 39 billion. So roughly one basis point 100th of 1% of global stocks and bonds. So even moving

a tiny fraction of Tradfi assets onchain is an is an enormous expansion of what DeFi can serve. And we're obviously very early here. The second TAM expansion though I think is arguably the more interesting one which is that RWAS need a lot more financial infrastructure around every dollar. So think about a meme coin on Salana, right? Maybe it needs spot trading, maybe a per if there's enough liquidity and then maybe a lending market if it has any collateral value whatsoever andor there's enough demand to short it and and that's basically it.

A treasury [snorts] is different though. You can trade it spot. You can finance it through repo. You can post it as collateral. You can hedge it with futures. Uh you can trade the rate separately via interest rate derivatives. And you can package it into compelling structured products that you know you would never do with a memecoin. So we're not just putting more assets on chain. We're actually creating a lot more financial activity around every dollar that comes on chain. [snorts] The obvious question then, you know, I'm a I'm a VC is who makes money from all of this? Um I think there are generally four opportunities kind of up and down the stack. So at the bottom is block space. So obviously more trading, more financing and more settlement generally means a persistent source of demand for

chains whether it it be an L1 or an L2. And then next the core DeFi primitives themselves are going to make money. Things like exchanges uh lending protocols, options protocols, rate derivatives protocols, these types of things. >> and then aggregation which is the prime brokerage layer we just talked about and then at the top you know whoever owns the customer relationship uh we've written about this actually on our blog we called it I believe the publisher exchange thesis which is basically that the app that owns the customer decides where trades get liquidity from uh where the collateral sits where yield is routed and which product the user sees and this gives them an an enormous amount of power from all of the protocols that are underneath them. I think broadly the higher up the stack

you are the more margin you're able to capture but again it's it's obviously very early and we don't know where the network effects are actually going to occur just yet. Uh this slide I think is quite important. Um, DeFi doesn't need to invent these new primitives that I'm talking about from scratch because we've already built a lot of them, right? Ribbon built covered called vault uh years ago and then so did friction and katana, but again the underlying was volatile crypto. Um, exponent they separate principle from yield and it's actually scaled pretty nicely in terms of TVL, but the most interesting yield that people are trading right now has been points programs which is just like not that compelling. [snorts] And then Boros built rate derivatives, but again the product that people trade the most

is perpending. And Project Zero, which I mentioned earlier, has built a unified margin protocol, but again, it's just really netting crypto exposure. So our view is that these products are not wrong. They're just early and the assets have not been ready yet, but they're now coming. [snorts] So to be clear, I don't think DeFi 1.0 is going to go anywhere, right? AMMs will continue to serve the long tale of tokens. uh per will remain a a main tool for crypto speculation and variable rate lending still makes sense for borrowers who are pseudonmous and and just want to lever up on their crypto assets. But the way I'd summarize the talk is, you know, the first phase of RWAS has been about getting assets on chain and that's what a lot of people here are working on. But the next phase is about actually

building real financial markets around these assets. Um, in DeFi, we've already built a lot of these primitives and so the assets are now finally catching up. And that's what we mean by Defi 2.0. [snorts] So, I know I covered a lot of ground today. Uh, if you want to read the full essay on our website that kind of unpacks our DI 2.0 thesis, you can scan the QR code here. If you're a builder that are working on any of these problem sets, please come find me after the talk or reach out to me on Twitter at uh Spencer Applebomb. Uh, thank you.